State policy effects on sulfur dioxide emission allowance trading

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Abstract

Title IV of the 1990 Clean Air Act Amendments established a market-based
incentive approach to pollution control through the use of tradable allowances for sulfur
dioxide (S02) emissions by electric utilities. Many researchers have theorized that this
approach will be compromised by state regulatory policies that create incentives for utilities
to invest in costly pollution control equipment, inhibiting the formation of a free and
competitive allowance market. The pUrpose of this research is to investigate the impact of
state regulatory policies on the development of the S02 allowance market. More
specifically, this research examines whether the geographic distribution of traded S02
allowances (as determined by an analysis of EPA Allowance Tracking System data) has
been affected by the actions of state regulators. The research also investigates the effect of
Title IV on the Virginia coal industry.

Several trends in the allowance market are identified in this study, including the
declining price of allowances, over compliance at Phase I units, and the geographic patterns
of trading. This research only partially supports earlier predictions that states with
regulatory policies biased towards costly capital investments in flue gas desulfurization
(scrubber) retrofits would become net allowance sellers in the national market. However,
the research finds that these state policies, along with several other factors (including the
Phase I Extension program, the tax treatment of allowances, and the risk-averse nature of
utilities) have contributed to the slow growth in the allowance market. The research also
concludes that Virginia low-sulfur coal producers are not benefiting from Title IV
implementation.